In property we trusted: making sense of Centro

Paddy Manning

When Centro faltered on December 13, 2007, it was the moment the credit crunch hit home in Australia.

We'd had the failure of RAMS Home Loans, quickly dubbed the worst float of the decade, but that was relatively small and right in the sub-prime warzone.

Centro was a top 50 company and one of our five biggest listed property trusts, with a market capitalisation of more than $10 billion and a property portfolio valued at $27 billion. This was blue chip - at least it was meant to be. Close watchers of the company knew Centro had been climbing up the risk curve for some time.

More than spivvy wannabes like the Rubicon Group, Centro was emblematic of everything that went wrong with listed property trusts as they morphed into fund managers:

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Its failure to refinance $2.7 billion in commercial mortgage-backed securities (CMBS) in the US debt market sparked an immediate meltdown in the listed property sector. The index dropped like a stone. Everyone rushed to clarify their debt profile. Any short-term loan expiries suddenly loomed large.

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Initial disbelief turned quickly to fear and, straight after Christmas, it was on. Highly geared vehicles dropped like flies. By February, ABC Learning, MFS, Allco Finance Group and City Pacific were in dire straits.

Andrew Scott, a former Myer executive, was Mr Centro, having run the business since 1997. He dominated the board, including the long-serving chairman Brian Healey.

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Even after Scott was removed as chief executive last year (though retained as a consultant), he was unrepentant about Centro's failure. That he failed to anticipate the vast CMBS market would shut down overnight was all he would admit.

But there was more to it than that. Centro, with its ''cemented funds under management'' and its ''recycling of capital'' was, until 2007, the way of the future for the listed property sector. In the bull market, it was admired for generating ever higher - albeit debt-fuelled - returns on equity for its shareholders and for unitholders in the listed and unlisted property funds empire it controlled through a cascading system of minority stakes and mirror boards.

Centro was once a boring manager of downmarket, grocery-anchored neighbourhood and sub-regional shopping malls. The group made a virtue of its rental income coming from non-discretionary spending.

In 2003 it paid well over the odds - eyebrows were raised - for the MCS property syndication business built up by Julius Colman.

Colman's genius had been to work out how to generate commissions for financial planners out of unlisted property investments. His sales pitch was clever, too: new-fangled listed property trusts performed like equities. They did not give client portfolios true diversification. Property syndicates were the answer (and the planner got about 15c in the dollar, right upfront).

With a formula like that, planners made sure Colman's MCS business grew like topsy. But it was Andrew Scott who made Colman really rich, paying $193.5 million for the funds business. Word at the time was that after that amazing deal, Colman served Grange at his barbecues. Publicly, Colman told one newspaper he thought Scott was a ''classy act''.

''I woke up the next morning convinced I had never been involved with, or met, a more impressive man than Andrew Scott,'' he said.

For a while Scott did look the business; he took the Colman model and souped it up. A bunch of single-asset, closed-end property syndicates that locked investors in - but which owned neighbourhood malls they could see and touch - developed into a mixed stable of open-ended, platform-friendly listed and unlisted funds with part-stakes in other funds and property assets all over the place.

The complexity reached its zenith with the 2006 spin-off of Centro Retail Trust. It was sold as a plain old boring property trust - safe, with a steady yield. (When the crunch came, it was anything but; cross-guarantees ensured unitholders were liable for debts across the Centro group.) If Centro Retail was the property trust, what now was Centro? The sector was evolving and not everyone was comfortable.

In those years, Australians were the biggest offshore buyers of US commercial property, driven by the likes of Centro and the Macquarie Group listed funds.

By 2007 Centro ran the fifth-biggest portfolio of shopping centres in the US, having hoovered up a big new portfolio basically every year - Watt, Kramont, Heritage, New Plan. But it was the New Plan portfolio that went bad.

A listed shopping centre developer and manager, New Plan had been trying to sell about 100 neighbourhood and community shopping centres since 2005. The portfolio was shopped around here and Centro was clearly not interested. Multiplex had a look but, smarting from the Wembley debacle, the instos told the group to stick to its knitting. In July that year a pared-back portfolio, ostensibly the better two-thirds, was bought by a small Australian outfit called Galileo Funds Management, run by a former AMP property executive, Neil Werrett, for $1.3 billion.

In May 2007, damn near the top of the market, Galileo sold pretty much the same portfolio to Centro for $2.4 billion - a gain of about $1 billion. Werrett was lucky enough to insist on cash - apparently $100 million.

The short-term finance for this transaction is what unravelled so disastrously six months later. Since then, Centro shareholders have been all but wiped out. Investors in many unlisted funds have had redemptions and distributions frozen for almost two years. Unitholders in two key unlisted funds, the Direct Property Fund and the Direct Property Fund International, have lost hundreds of millions of dollars.

Their plight is the silent scream of the GFC. They will be happy to hear legal action is finally being taken.